Market toasts the EFSF insurance plan, though risks loom

The market continues to toast the EFSF insurance plan, but the next key risks for confidence in the EU looms in Greece tomorrow.  Meanwhile, another upside surprise in US housing data – how can it be?

Unanimous BoE
The Bank of England minutes showed that the MPC was unanimous in calling for the GBP 75 billion expansion of the asset purchase target and no change to the interest rate and spent much of its time fretting about the global situation (particularly Europe) and the extent to which inflation was transitory, as Nick Beecroft discussed today. The market had a tough time deciding whether it should be surprised by the news, at first thinking that the development was dovish because none dissented from the announced size of the asset purchase expansion, but sterling quickly found its feet again – pressing back higher toward the key 1.5800/50 area in GBPUSD, which is the last resistance ahead of perhaps 1.60 or even the currently 1.5960 55-day moving average. The pair is clearly being taken higher by the general environment of risk appetite and pro-Euro sentiment, as a look at interest rate spreads shows little support for a large extension of the current rally.

Chart GBPUSD
The 1.5800/50 area has been under fire lately, and the final resistance areas higher from here are the 55-day moving average, currently around  1.5960 and the psychologically significant 1.60 level followed by the 200-day moving average a bit higher. We’re having a hard time finding further drivers for the pair beyond these resistance levels.



EFSF – the latest
The relatively novel “build the EFSF insurance and the private money will come” approach to EU sovereign debt, (in other words, encourage private capital and deep pocketed sovereign wealth funds to invest in EU sovereign bonds by offering first-loss bond insurance) is seeing remarkable sums representing the imagined bailout potential of the proposed EFSF structure thrown around - EUR 2 trillion and above in some cases. As we mentioned yesterday and as Moody’s made clear yesterday regarding its warnings on the French rating outlook, the problem is one of “self insurance” and the idea of Spain and Italy putting up funds in the event of a stressful scenario is non-serious.

A piece over at FTAlphaville today runs through some of the math to discuss the real firepower the EFSF may bring to bear, and it is a fraction of the largest numbers being thrown about, and a small fraction depending on the degree of French wobbliness in the calculations. In the end, the two critical factors will be market confidence and EU solidarity, which effectively go hand in hand. On the former, one can argue that the math for continuing to roll over EU debt adds up (for a time, at least) if sufficient private funds belly up to the bar in combination with the proposed EFSF insurance scheme being fully in place. But what happens in the event EFSF funds must actually begin to be deployed in the event of failed auctions  or the like – one that could be triggered by cratering confidence. Then the question quickly becomes one of whether the center can hold and when, if ever, the ECB prints money to act as the buyer of last resort. The bottom line is that the best case here is a stabilization for an unknown period, not the prospect of a liquidity bonanza similar to the US Fed’s QE2.

Norges Bank maintains rate
Norges bank was happy to maintain its rate at 2.25% as the majority of the market expected and had little to say to jolt expectations in either direction from here. The statements suggested that current economic activity was a bit slower than expected, but that no slowdown is expected and that inflation is expected to gradually rise toward the target. The bank was encouraged by the signs from Europe and said it preferred to maintain rates unchanged rather than make “temporary cuts”. Judging from the market reaction (NOK a bit weaker) relative to a relatively hawkish message and what is going on elsewhere, it appears that the market had already largely priced in a more hawkish stance. EURNOK has been in an ice age for the last 10 months save for a brief swoon in mid September. It’s normal slightly pro-cyclical and pro-crude oil correlation is coexisting somewhat awkwardly with some viewing it as a safe haven due to the strength of the Norwegian sovereign.

US Data
What is this? Strong US housing data for two days in a row? Yesterday we had a much stronger than expected NAHB survey, which measures traffic at new housing developments, and today we get a strong Housing Starts print. Not sure whether this is a mere blip, but there may be a couple of drivers here. The obvious one is very low interest rates of late, which continue to make it cheaper to buy - particularly as the 30-year part of the curve has dropped the most in recent months since the brief late 2008 swoon. The second factor may be simply increased turnover, as news has emerged that more banks are allowing short sales on homes rather than waiting until a foreclosure is necessary as it finds this cheaper. This could be increasing the rate of sales (which apparently take place at higher prices than those for foreclosed homes), and thus leading to more mobility of the work force and a marginal increase in new home traffic. This is a spot of good news for the US economy, even if it proves only mildly supportive for a few months at best.

The CPI came in lower than expected, but the market decided not to focus on this data, or perhaps decided that the core is a silly measure anyway and the reality of 3.9% headline inflation isn’t pretty for an economy/currency with 0% interest rates. Either that, or the focus was initially on the positive housing data.

Looking ahead
The two-day strike in Greece is under way as Greek 1-year yields marched to a new record high of 182%, up 60% for this month alone. Tomorrow sees the voting on a key austerity package that some in the ruling party have said they would resist – this is an important event and could keep a cap on the Euro until the outcome is known. Then again, the rally’s strong renewal late yesterday and today after all of the negative news flow yesterday can hardly be bolstering the confidence of the Euro bears here. Stay tuned.